CEO succession plans enjoy little success, endanger shareholders

Top executives looking to ascend to the CEOs chair shouldn't count on getting there through their companies' succession plans. According to executive search firm Heidrick & Struggles (HSII), only 55 percent of Fortune 1000 companies choose to hire their successors from within.

Heidrick & Struggles pointed out that, of the 80 new CEOs who were appointed among Fortune 1000 companies in 2008, only 44 were promoted from within. This shocking statistic raises an interesting question: if corporate boards are only successful 55 percent of the time in identifying capable internal candidates to handle the most important job at the company, it's worth asking if they can effectively prepare for other critical matters that a company might face.
"While almost all companies technically have a succession plan in place, the fact that 45 percent of them had to go outside to hire a CEO means that many of these plans failed to hit the mark," said Heidrick & Struggles vice chairman and managing partner, Stephen Miles. "CEO turnover in and of itself adds to employee and shareholder anxiety, but this 'fail rate' contributes to even wider concerns among corporate stakeholders during the current recession."

Miles said that, even though companies are complying with stricter corporate governance regulations regarding this matter, "the plans were not truly operational. They involve just checking boxes, which is a real risk for shareholders."

Bank of America's (BAC) investors are dealing with that risk firsthand as the company scrambles to find a successor to Ken Lewis, who announced he would retire as head of the bank at year's end. "We worry that the list of able candidates willing to take on this mammoth bank with so many reputational and legal woes could be very short indeed," said Morningstar analyst Jaime Peters in a September 30 analyst note following Lewis' announcement. "A new CEO will need to not only deal with the massive amount of loan losses building on B of A's book, but the integration of Merrill Lynch and the legal hassle that the government brings to the table."

While the market seemed to react positively to Lewis' departure, finding the right replacement will be critical to the company's stock performance. The fact that no clear candidate within the bank was positioned to succeed Lewis even as he underwent a public grilling on Capital Hill this summer underscores the shortcomings of corporate succession plans. Bank of America's board can't say that they didn't see this coming, so their apparent inability to prepare for Lewis's succession must be worrying investors

Citigroup (C) appears to have a similar dilemma. As reported by Jonathan Berr of DailyFinance earlier this month, Citi CEO Vikram Pandit has managed to survive in his job in spite of poor performance because of the perception that there are few candidates who could do a better job with the struggling financial institution.

The recent death of Bruce Wasserstein, CEO of Lazard Ltd (LAZ) points out another potential problem for firms that don't have a clear succession plan. While the firm was able to quickly appoint an interim CEO, an internal competition between executives Kenneth Jacobs, Charles Ward and Gary Parr could be devastating. As Rochdale Securities analyst Richard Bove noted in a Bloomberg report, "What they now have to be worried about is if three guys want to be CEO and they can only pick one, the other two will get all upset and walk out, [taking] all the business with them."

Succession plans primarily fail due to a lack of communication and cooperation between the sitting CEO and the board of directors. Miles said that the CEO often has ideas about who the company's successor should be, but in many cases the board has had very little exposure to internal candidates, and therefore cannot properly judge their ability to run the company. Also the CEO's input on who is capable is often not communicated to the board of directors, leaving internal candidates' struggling to position themselves for the top job after being seen in a lesser role for many years at the company.

"Part of developing successors is ensuring they are 'viable candidates' in the eyes of the board of directors – not just the CEO," notes Miles. "This requires a programmatic approach using external resources to validate candidates and develop them over time." To do this, boards may have to look beyond the CEOs direct-reports in the C-suite, to other key executives who have the skills to handle the new industry challenges and changing economic environments that the company might face.

With executive compensation being scrutinized by Washington's pay czar Kenneth Feinberg and angry shareholders, one might think that directors at major corporations would make sure that viable candidates to succeed their current CEO are in place. Since the board is the body that will ultimately make the decision to hire any new CEO, it behooves them to make sure that the process of replacing the chief executive does not endanger the company's long-term survival or its short-term stock value.